Summary Article

The World Depends On The Dollar

We recently downsized to a smaller house and have been giving items away to friends, family and the local thrift store. We have also been selling things on Craigslist and Facebook: excess beds, a couch, kitchen table, chairs, a treadmill, a John Deere riding mower, a snow blower, etc.

One result of this great unburdening is for the first time in many years I have a lot of cash in the form of paper money stuffed in my billfold.

I am awkward with it. The bills are crumpled together, and when I count them out to buy a meal at a restaurant, I’m a little embarrassed by how out of practice and clumsy I am in handling cash.

I used to be so much better at counting out coins and bills. When I lived in Mexico in the mid-eighties in an era of hyperinflation, I only used cash and could easily manipulate the money in my hand to pay for goods and services.

Now with the proliferation of direct deposit, debit cards, and online bill pay, I’m not the only one using less physical money. In many advanced economies, the use of paper bills and coins has plummeted.

For example, the amount of Swedish paper notes and coins in circulation has dropped by 40% since 2009 according to the Financial Times.

India’s Cash Shortage

Meanwhile, the developing world is still a predominately cash society. The populace in India was recently sent into turmoil after the surprise announcement by the federal government that they were annulling all of the country’s existing 500 rupee and 1,000 rupee bank notes and replacing them with new 500 and 2,000 rupee notes. That equates to 86% of the money in circulation or about $223 billion.

Alok Prasad, a senior banker, told the Financial Times, “It’s a logistic nightmare replacing 22 billion pieces of paper across a population of 1.2 billion in a country the size of India.”

The purpose of the exchange program is to flush out so called “black money” that was earned illegally or not reported to tax authorities.

The impact was immediate as ATMs no longer worked and long lines formed at banks with citizens and tourists waiting to exchange bills and get access to cash that they needed to buy food and other supplies.

Construction worker Madhya Pradesh told the Financial Times, “I didn’t have any food last night because the grocer didn’t accept any of these [old] notes.” Smaller bank notes have stopped circulating as people hoard the remaining supply due to the cash shortage.

Zimbabwe’s Dollar Shortage

At least the cash shortage in India will eventually work itself out. The situation in Zimbabwe is much more severe.

Zimbabwe has used the U.S. dollar as its main currency since 2009 after inflation hit 500 billion percent, causing the local currency to collapse.

Since Zimbabwe imports more than it exports, many of those U.S. dollars flow out of the country, making it difficult for banks to meet customers’ demand for U.S. dollars to buy basic goods and services.

The Zimbabwe government announced a program to issue “bond notes” backed by U.S. dollars to ease the cash crunch, but it is unclear whether people will trust the new notes.

“The bond note is as good as a leaf in my garden. What a load of rubbish,” Tendai Biti, Zimbabwe’s former finance minister told Foreign Policy.

The irony is the U.S. dollar bill isn’t much different than a garden leaf. As a fiat currency, the U.S. dollar is not backed by anything. It has no intrinsic value. The biggest difference between a garden leaf and a dollar bill is people believe the dollar has value. They trust it. And they use it.

The Global Use of the Dollar

SWIFT, the leading global provider of interbank messaging on financial transactions, estimates in 2014 the U.S. dollar comprised 52% of worldwide currency usage in international cross-border transactions for trade and investing compared to 48% in 2012. The euro ranked second with 31% of currency usage. The British pound came in a distant third at 5%.

Most commodities, including oil, are traded and priced in dollars. The U.S. dollar is also the borrowing currency of choice.

According to the Bank For International Settlements, in mid-2014, U.S. dollar denominated credit to non-financial borrowers outside the U.S., such as households, businesses and governments, was $8 trillion compared to $2.5 trillion denominated in euros and $0.6 trillion in yen.

The U.S. dollar is the dominant currency for trade, investing and borrowing because the U.S. has the deepest, most liquid, financial markets, it is the largest economy in the world and it runs the largest trade deficit.

In other words, there is an abundance of dollars flowing into the world that can be used for trading and investing.

The Supply of Dollars Is Limited

The rise in global trade has made the world ever more dependent on the dollar as complex global supply chains require working capital to source, manufacture and transport goods and services.

Much of that working capital is borrowed in U.S. dollars from banks. But banks’ willingness to lend in U.S. dollars is not unlimited.

A recent paper by Hyun Song Shin, Head of Research at the London School of Economics and Political Sciences, showed that when the dollar is strengthening as it has been the past eighteen months the willingness of banks to lend in dollars slows.

That is because when the dollar strengthens, foreign borrowers need to generate more income in their weakening local currency to service their U.S. dollar denominated debt. The borrowers become greater credit risks to banks so banks become less willing to lend.

This reduced lending can then negatively impact global supply chains due to an inability to access needed working capital. The strengthening dollar could be one reason global trade volume growth has been slowing and the value of global trade has declined since mid 2014.

Global Dollar Shortage

There is a risk that the U.S. dollar shortage currently plaguing Zimbabwe could go global if the U.S. dollar continues to strengthen and if the Trump administration implements some of its promised reforms.

Analyst Izabella Kaminski recently wrote in the Financial Times Alphaville column that a global dollar shortage “stands to become the most significant destabilizing force in recent times and the most unanticipated global tail-risk.”

When something is in short supply, its price goes up. Those worried about a dollar crash, might want to consider the opposite risk: the fallout from a dollar that is too strong due to an inadequate supply.